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Questions Follow Leader of For-Profit Colleges

In 2004, when Todd S. Nelson was chief executive of the University of Phoenix, the nation’s largest for-profit college, he signed a $9.8 million settlement with the Department of Education, which found that Phoenix had “systematically and intentionally” broken the federal rules against paying recruiters for students.

Mr. Nelson is now chief executive of the nation’s second-largest for-profit college company, Education Management Corporation, or EDMC, and the Justice Department and two state attorneys general are intervening in a whistle-blower lawsuit charging that EDMC also violated the ban on what is known as incentive compensation. That practice encourages aggressive recruitment of unqualified students for their federal student aid.

Given the cast of characters — along with Mr. Nelson, a half dozen former Phoenix executives are now at EDMC — the complaint against EDMC says that “senior management knows that the compensation system it administers violates the incentive compensation ban.”

Phoenix never admitted any wrongdoing, either in the settlement with the Education Department or in a later $78.5 million settlement in the whistle-blower suit that had led to that inquiry. Education Management, which enrolls about 150,000 students at Argosy University, Brown Mackie College, South University and in its Art Institutes, has said it plans a vigorous defense.

“We feel very comfortable, based on the advice we got from our lawyers, that it does not violate the law,” Anthony J. Guida Jr., EDMC’s senior vice president for regulatory affairs, said of the compensation plan. He added that it was reviewed by two law firms before it was carried out in 2003, and has been periodically evaluated since.

Mr. Nelson joined the company in 2007 and had nothing to do with designing the pay policy that went into effect in 2003, Mr. Guida noted. The chief executive before him was Jock McKernan, a former governor of Maine who still serves as chairman of the board. A company spokeswoman said neither Mr. Nelson nor Mr. McKernan was available for interviews.

Apart from the financial consequences for the colleges, the lawsuit could have political fallout: Mr. McKernan is married to Senator Olympia Snowe, a Republican from Maine whose 2010 financial disclosure form lists EDMC stock and options worth $2 million to $10 million. Scott D’Amboise, who is challenging her in the 2012 Republican primary, has called on Ms. Snowe to resign because she benefited from her husband’s receiving “millions of our hard-earned tax dollars.” Senator Snowe declined to comment.

This is the first time that prosecutors have joined a suit like the EDMC whistle-blower case, and the government’s unprecedented intervention in such a compensation case comes amid escalating controversy over for-profit colleges. Enrolling about 12 percent of the nation’s higher-education students, the colleges get a quarter of all federal student aid and account for nearly half of all student loan defaults. Last Friday, the Department of Education released new data showing that more than 15 percent of those who had attended for-profit colleges defaulted within two years — twice the rate of those who attended public institutions, and three times as many as those who went to private not-for-profit colleges.

Harris Miller, president of the Association of Private Sector Colleges and Universities, said the for-profit colleges’ higher default rates were in part attributable to their serving lower-income students than other institutions.

The industry, which gets more than three-quarters of its revenue from federal student aid, has been under increasing scrutiny from Congress and the Obama administration.

“Once you get to a certain size and saliency, a lot more people start paying attention to you,” Mr. Miller said.

This month, Kentucky’s attorney general, Jack Conway, announced that he and his counterparts in 10 other states had formed a working group to investigate the for-profit colleges’ possible violations of consumer protection laws.

And soon, the Department of Education is expected to issue a regulation cutting off federal student aid to for-profit programs whose graduates have high debt loads and little earning power. The proposed regulation, known as the “gainful employment” provision, has spurred an intense lobbying campaign by the for-profit college industry and its allies, and was sent to the White House Office of Management and Budget for review this month.

The complaint against EDMC charges that its compensation plan is very much like the one at the University of Phoenix, which the Department of Education found in 2004 “provides substantial incentives to its staff to recruit unqualified students” and “operates in a duplicitous manner” to evade detection.

According to the complaint, EDMC’s pay plan is based entirely on enrollment numbers, with additional factors mentioned in company policies serving only as window dressing. “It’s a boiler-room telemarketing scheme, where your numbers are all that counts,” said Harry Litman, a Pittsburgh lawyer representing the whistle-blowers. “That’s O.K. for telemarketers, but it’s not O.K. in education.”

Mr. Guida said that he could not discuss specific accusations in the complaint, but that the plan was designed around what is known as a “safe harbor” in the law that says a recruiter’s pay can take into account how many students are brought in, as long as that is not the sole basis for the pay.

Some for-profit executives are puzzled that the Justice Department is intervening in the case at a time when the “safe harbor” in the law is about to be closed: under Education Department regulations that take effect in July, recruiters can no longer be compensated for each student they enroll, even if their enrollment numbers are not the sole basis for the pay.

Mr. Miller’s group has sued the department, arguing that the new rules overreach its authority, and that they will make it difficult for for-profit schools to attract talented recruiters.

Under the federal False Claims Act, whistle-blowers may sue on behalf of the government to recover money paid out as a result of fraud. In two dozen such cases filed against for-profit colleges since 1999, the fraud accusations involve the signing of yearly forms certifying that they do not use incentive compensation. Some of the cases are still pending, some have been settled and others dismissed.

This month, the Justice Department and the attorneys general of California and Illinois announced that they would intervene in the case against EDMC, bringing to bear all the resources of their governments in pursuing the case. That would usually lead to a larger settlement or award. The False Claims Act allows damages of up to $11,000 for each fraudulent claim, plus triple the damages.

With the explosive growth of the for-profit sector, the sums involved are immense. Education Management, which is 40 percent owned by Goldman Sachs, received more than $855 million in federal student aid in 2003-4, and more than $1 billion in 2005-6. According to the complaint, in the fiscal year ending June 30, 2010, it received more than $2.2 billion in federal student aid, representing 89.3 percent of its net revenue.

Nancy Krop, one of the lawyers who handled the Phoenix litigation, said that because the industry’s revenues from federal student aid had grown so quickly, it would take a very large damage award — something that would be difficult to obtain without Justice Department intervention — to make a dent in profits.

“At the University of Phoenix, they got billions of dollars in federal aid,” she said. “So even paying $78 million to settle a case, they end up with a lot of money.”

A version of this article appears in print on May 27, 2011, on page A12 of the New York edition with the headline: Questions Follow Leader Of For-Profit Colleges. Order Reprints|Today's Paper|Subscribe